Margin loans are loans that are usually arranged through brokers and allow investors to borrow money for the express purpose of purchasing stocks and other investments. The idea is that as the investment posts returns, the investor repays the brokerage or securities firm through the margin account associated with the investment activity. In many cases, this arrangement benefits both parties. Along with the beneficial aspects of the arrangement, there is also some opportunity for the arrangement to fail and create difficulties for both the brokerage and the investor.
Under the best case scenario, margin loans provide the capital needed for an investor to secure an stock or other type of security that is projected to produce a significant amount of revenue within a specific time frame. By obtaining the loan, the investor does not have to risk his or her existing assets in the venture. This makes it possible to continue using those other assets for additional investments, or to utilize the dividends from those assets for living expenses or any other purpose the investor finds desirable.
Brokers benefit from the use of margin loans, since the measure makes it possible for their clients to engage in trading activity that would likely not occur otherwise. From this perspective, the brokerage has the benefit of receiving income in the way of fees and other charges associated with their role in executing the trades on behalf of the investor as well as managing the newly acquired assets on behalf of the investor. These opportunities to earn more income for the brokerage would not take place if margin loans were not available to fund margin accounts and allow qualified investors the change to buy investments on margin.
While margin loans can be very productive, there is some degree of risk involved. If the investment that is purchased using the proceeds generated by the loan and placed in a margin account fails to perform as expected, the investor may incur a loss. In spite of the loss, the investor must still repay the balance of the loan. This will often mean not only selling off the shares at a price lower than the purchase price but also having to sell off other assets in order to settle any remaining debt associated with the failed investment attempt. Failure to do so in a timely manner could result in the suspension of the privilege of being able to buy investments on margin, a move that could seriously hamper the investor’s ability to grow his or her portfolio in the future.